16 October 2023

How do rural businesses access and use external finance?

Two studies

Access to finance is often considered as one of the main obstacles to business growth, writes Thao Nguyen, Research Associate. Previous studies in the UK show that there is spatial disparity in accessing external finance, with areas located closer to financial hubs (such as London and the South East) facing fewer challenges in accessing finance. Thus, it is of interest to the National Innovation Centre for Rural Enterprise (NICRE) to understand if rural businesses, which are located further away from financial hubs, and in some cases in remote areas, face difficulties in accessing external finance, and the implications of that on their business growth.

We have undertaken two studies to better understand the financial journey of small- and medium-sized businesses (SMEs) located in rural and urban economies. The first looked at rural businesses’ need for external finance, their application behaviour, and decisions made by financiers. The other study explored which types of external finance are used by rural SMEs and what they use it for, as well as how the obtained finance affects their growth.

Comparing rural and urban businesses

Research we’ve just published shows that overall, at an aggregate level, there are more similarities than differences when comparing urban and rural businesses regarding their access to external finance. For example, similar proportions of rural and urban businesses express a need and apply for external finance. Moreover, the chances of being rejected after having applied for finance are similar in urban and rural areas.

However, these broad-brush findings mask variations across rural areas, with businesses located in hamlets and isolated dwellings - considered the most rural - having different experiences from those in villages and town and fringe locations.

For example, businesses located in rural hamlets and isolated dwellings are more likely to express a need for external finance compared to firms in other rural and urban settings. Businesses in hamlets are also often less likely to be discouraged borrowers, which means them not applying for finance even though they need it. This contrasts with the picture for SMEs in town and fringe locations which often have the highest rates of discouraged borrowing.

In addition, businesses in hamlets and isolated dwellings have higher likelihood of rejection than those in the other rural settings. These findings point to areas where there may be a mismatch between rural firms’ perception of getting access to external finance and their actual likelihood. It may imply that there are potential differences in firms’ confidence in their own creditworthiness or level of information to self-assess their chance of successful applications.

Types of finance, use and impacts on growth

Moving onto businesses which obtained external finance – as set out in our research published earlier this year – we examined what types of external finance are more common among rural SMEs. We found that rural firms are more dependent on debt finance than urban firms, particularly overdrafts and credit cards.

While debt finance is the most popular choice of external finance, equity finance is used significantly less by both rural and urban SMEs, with rural firms more likely to seek equity finance from family and friends.

Rural firms tend more often to seek external finance for equipment and vehicles than urban firms, and vice versa for staff training and development. Differences such as these may be due to the type of finance available to them or different priorities within the businesses.

Considering the impacts of external finance on business growth, we were surprised to find that this is stronger for rural firms than for urban firms, after taking into account differences in business profiles, such as sectors, size, age and growth expectation. In other words, rural SMEs are able to achieve better business growth with the same amount of finance than urban firms. It could suggest that either rural firms are more effective in leveraging the benefits of external finance, or they depend more on external finance for financing growth than urban firms. I’m looking forward to trying to explain this in future through further research at NICRE and by hearing more from businesses and finance providers.